<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly period ended August 31, 1996
Commission file number 1-9085
MORGAN STANLEY GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware 13-2838811
- - ---------------------------------- -----------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1585 Broadway, New York, New York 10036
- - -------------------------------------------- --------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 761-4000
-------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes (X) No ( )
As of September 30, 1996, there were 152,428,788 shares of Common
Stock, $1 par value, outstanding.
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TABLE OF CONTENTS
- - -------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statement of Financial Condition at
August 31, 1996 (Unaudited) and November 30, 1995.
Condensed Consolidated Statement of Income (Unaudited) for
the Three and Nine Months Ended August 31, 1996 and August
31, 1995.
Condensed Consolidated Statement of Cash Flows (Unaudited)
for the Nine Months Ended August 31, 1996 and August 31,
1995.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 6. Exhibits and Reports on Form 8-K
Signatures
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MORGAN STANLEY GROUP INC.
CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(IN MILLIONS)
<TABLE>
<CAPTION>
ASSETS
August 31,
1996 November 30,
(Unaudited) 1995
----------- -------------
<S> <C> <C>
Cash and interest-bearing equivalents $ 3,460 $ 2,471
Cash and securities deposited with clearing organizations or segregated under
federal and other regulations (securities at market value of $2,479 at
August 31, 1996 and $859
at November 30, 1995) 2,758 1,339
Financial instruments owned:
U.S. government and agency securities 10,232 12,480
Other sovereign government obligations 13,598 13,792
Corporate and other debt 13,347 10,690
Corporate equities 9,352 13,185
Derivative contracts 8,245 8,043
Physical commodities 396 410
Securities purchased under agreements to resell 61,673 45,886
Securities borrowed 35,023 27,069
Receivables:
Customers 5,087 3,413
Brokers, dealers and clearing organizations 1,943 1,475
Interest and dividends 1,123 1,082
Fees and other 586 506
Property, equipment and leasehold improvements, at cost, net of accumulated
depreciation and amortization of $576 at August 31, 1996 and $462
at November 30, 1995 1,287 1,286
Other assets 1,116 626
-------- --------
Total assets $169,226 $143,753
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements. Page 3
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Morgan Stanley Group Inc.
Condensed Consolidated Statement of Financial Condition
(In millions, except share data)
Liabilities and Stockholders' Equity
<TABLE>
<CAPTION>
August 31,
1996 November 30,
(Unaudited) 1995
---------- ------------
<S> <C> <C>
Short-term borrowings $ 11,581 $ 11,703
Financial instruments sold, not yet purchased:
U.S. government and agency securities 10,489 6,459
Other sovereign government obligations 6,417 8,972
Corporate and other debt 933 1,076
Corporate equities 7,378 3,585
Derivative contracts 6,733 7,537
Physical commodities 76 71
Securities sold under agreements to repurchase 76,992 60,738
Securities loaned 7,726 9,340
Payables:
Customers 15,486 13,818
Brokers, dealers and clearing organizations 1,429 1,974
Interest and dividends 1,142 1,019
Other liabilities and accrued expenses 908 595
Accrued compensation and benefits 1,676 1,192
Long-term borrowings 13,864 9,635
-------- --------
162,830 137,714
-------- --------
Capital Units 865 865
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock 878 818
Common stock, $1.00 par value; authorized
600,000,000 shares; issued 166,366,653
shares at August 31, 1996 and 162,838,920
shares at November 30, 1995 166 163
Paid-in capital 690 730
Retained earnings 4,473 3,815
Cumulative translation adjustments (14) (9)
-------- --------
Subtotal 6,193 5,517
Less:
Note receivable related to sale of
preferred stock to ESOP 87 89
Common stock held in treasury, at cost
(13,946,864 shares at August 31, 1996 and
7,635,174 shares at November 30, 1995) 575 254
-------- --------
Total stockholders' equity 5,531 5,174
-------- --------
Total liabilities and stockholders' equity $169,226 $143,753
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements. Page 4
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Morgan Stanley Group Inc.
Condensed Consolidated Statement of Income (Unaudited)
(In millions, except share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
August 31, August 31, August 31, August 31,
1996 1995 1996 1995
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Investment banking $ 431 $ 355 $ 1,372 $ 871
Principal transactions:
Trading 427 352 1,696 989
Investments 29 69 60 82
Commissions 148 130 461 372
Interest and dividends 2,144 1,899 6,023 5,501
Asset management and administration 137 96 402 275
Other -- 1 3 4
------------ ------------ ------------ ------------
Total revenues 3,316 2,902 10,017 8,094
Interest expense 2,029 1,751 5,753 5,139
------------ ------------ ------------ ------------
Net revenues 1,287 1,151 4,264 2,955
------------ ------------ ------------ ------------
Expenses excluding interest:
Compensation and benefits 645 575 2,100 1,416
Occupancy and equipment 89 84 261 247
Brokerage, clearing and exchange fees 65 64 199 185
Communications 38 31 105 99
Business development 37 30 116 107
Professional services 58 37 153 121
Other 40 32 119 100
Relocation charge -- -- -- 59
------------ ------------ ------------ ------------
Total expenses excluding
interest 972 853 3,053 2,334
------------ ------------ ------------ ------------
Income before income taxes 315 298 1,211 621
Provision for income taxes 96 89 418 199
------------ ------------ ------------ ------------
Net income $ 219 $ 209 $ 793 $ 422
============ ============ ============ ============
Earnings applicable to common shares (1) $ 204 $ 192 $ 745 $ 373
============ ============ ============ ============
Average common and common equivalent
shares outstanding (1)(2) 154,034,233 157,236,918 155,305,534 155,249,074
============ ============ ============ ============
Primary earnings per share (2) $ 1.32 $ 1.23 $ 4.79 $ 2.41
============ ============ ============ ============
Fully diluted earnings per share (2) $ 1.27 $ 1.17 $ 4.59 $ 2.29
============ ============ ============ ============
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) 1995 share and per share amounts have been retroactively adjusted to give
effect for the two-for-one common stock split, effected in the form of a
100% stock dividend, which became effective in January, 1996.
See Notes to Condensed Consolidated Financial Statements. Page 5
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Morgan Stanley Group Inc.
Condensed Consolidated Statement of Cash Flows (Unaudited)
(In millions)
<TABLE>
<CAPTION>
Nine Months Ended
August 31, August 31,
1996 1995
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 793 $ 422
Adjustments to reconcile net income
to net cash used for operating activities:
Relocation Charge -- 59
Non-cash charges included in net income 120 223
Changes in assets and liabilities:
Cash and securities deposited with
clearing organizations or segregated
under federal and other regulations (1,419) 1,671
Financial instruments owned, net of
financial instruments sold, not yet purchased 7,756 (435)
Securities borrowed, net of securities loaned (9,568) 5,176
Receivables and other assets (2,420) 440
Payables and other liabilities 2,008 (2,686)
------- -------
Net cash (used for)/provided by for operating activities (2,730) 4,870
Cash flows from investing activities:
Net payments for:
Property, equipment and leasehold
improvements (114) (308)
------- -------
Net cash used for investing activities (114) (308)
Cash flows from financing activities:
Net proceeds related to short-term borrowings (137) (1,261)
Securities sold under agreements to
repurchase, net of securities
purchased under agreements to resell 467 (2,083)
Proceeds from:
Issuance of common stock 88 56
Issuance of long-term borrowings 5,724 1,832
Issuance of Capital Units -- 344
Issuance of 7-3/4% Cumulative Preferred Stock 195 --
Payments for:
Purchase of Miller Anderson & Sherrerd, LLP, net
of cash acquired (200) --
Repurchases of common stock (507) (113)
Repayments of long-term borrowings (1,532) (1,141)
Redemption of 9.36% Cumulative Preferred Stock (138) --
Cash dividends (127) (95)
------- -------
Net cash provided by/(used for) financing activities 3,833 (2,461)
------- -------
Net increase in cash and interest-bearing equivalents 989 2,101
Cash and interest-bearing equivalents, at
beginning of period 2,471 2,135
------- -------
Cash and interest-bearing equivalents, at end of period $ 3,460 $ 4,236
======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements. Page 6
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MORGAN STANLEY GROUP INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(IN MILLIONS)
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
In connection with the Company's acquisition of Miller Anderson & Sherrerd, LLP,
the Company issued approximately $66 million of notes payable, as well as
2,012,264 shares of common stock having a fair value on the date of acquisition,
January 3, 1996, of approximately $83 million.
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MORGAN STANLEY GROUP INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation
On February 28, 1995, the Board of Directors approved a change in the Company's
fiscal year-end from January 31 to November 30. The change became effective for
the fiscal period ended November 30, 1995, and, accordingly, this report
includes the results for the third quarter and nine months ended August 31,
1996. As a result of this change, the comparable nine month period of the prior
year includes the final two months of fiscal 1994 (December 1994 and January
1995) and the first seven months of fiscal 1995.
The information furnished in this quarterly report has been prepared pursuant to
the Securities and Exchange Commission's rules and regulations. The Condensed
Consolidated Financial Statements reflect all adjustments (consisting only of
normal recurring adjustments) which are, in the opinion of management, necessary
for the fair statement of the results for the interim period and should be read
in connection with the Annual Report on Form 10-K for the fiscal period ended
November 30, 1995 (file no. 1-9085)("Form 10-K"). The nature of the business of
Morgan Stanley Group Inc. and its domestic and foreign subsidiaries
(collectively, the "Company") is such that the results of any interim period may
not be indicative of the results for the full year. Prior period financial
statements have been reclassified, where appropriate, to conform to the fiscal
1996 presentation.
Financial instruments, including derivatives, used in the Company's trading
activities are recorded at fair value, and unrealized gains and losses are
reflected in trading revenues. Interest revenue and expense arising from
financial instruments used in trading activities are reflected in the Condensed
Consolidated Statement of Income as interest income or expense. The fair values
of the trading positions generally are based on listed market prices. If listed
market prices are not available or if liquidating the Company's positions would
reasonably be expected to impact market prices, fair value is determined based
on other relevant factors, including dealer price quotations and price
quotations for similar instruments traded in different markets, including
markets located in different geographic areas. Fair values for certain
derivative contracts are derived from pricing models which consider current
market and contractual prices for the underlying financial instruments or
commodities, as well as time value and yield curve or volatility factors
underlying the positions. Purchases and sales of financial instruments are
recorded in the accounts on trade date. Unrealized gains and losses arising from
the Company's dealings in over-the-counter ("OTC") financial instruments,
including derivative contracts related to financial instruments and commodities,
are presented in the accompanying Condensed Consolidated Statement of Financial
Condition on a net-by-counterparty basis consistent with Financial Accounting
Standards Board ("FASB") Interpretation No. 39, "Offsetting of Amounts Related
to Certain Contracts." Reverse repurchase and repurchase agreements are
presented net-by-counterparty where net presentation is consistent with FASB
Interpretation No. 41, "Offsetting of Amounts Related to Certain Repurchase and
Reverse Repurchase Agreements."
The Company also enters into various financial instrument related derivative
contracts, such as interest rate swaps, currency swaps and forward contracts, as
an end user to manage the interest rate and currency exposure arising from
certain borrowings. Net revenues from derivatives used in the Company's own
asset and liability management are recognized ratably over the term of the
contract as an adjustment to interest expense.
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Equity securities purchased in connection with merchant banking and other
principal investment activities are initially carried in the Condensed
Consolidated Financial Statements at their original cost; the carrying value of
such investments is adjusted upward only when changes in the underlying fair
values are readily ascertainable, generally as evidenced by substantial
transactions occurring in the marketplace which directly affect their value.
Downward adjustments relating to such equity securities are made in the event
that the Company determines that the eventual realizable value is less than the
carrying value. Loans made in connection with such activities are carried at
unpaid principal balances plus accrued interest less reserves, if deemed
necessary, for estimated losses.
Included in the Company's Condensed Consolidated Statement of Financial
Condition at August 31, 1996 and November 30, 1995 are $865 million of Capital
Units issued by the Company and Morgan Stanley Finance plc., a U.K. subsidiary
("MS plc"). A Capital Unit consists of (a) a Subordinated Debenture of MS plc in
the principal amount of $25 guaranteed by the Company and having maturities from
2013 to 2015, and (b) a related Purchase Contract issued by the Company, which
may be accelerated by the Company beginning approximately one year after the
issuance of each Capital Unit, requiring the holder to purchase one Depositary
Share representing ownership of a 1/8 interest in the Company's Cumulative
Preferred Stock.
Earnings per share is based on the weighted average number of common shares and
share equivalents outstanding and gives effect to preferred stock dividend
requirements. Common share data for fiscal 1995 have been retroactively adjusted
to reflect a two-for-one common stock split, effected in the form of a 100%
stock dividend, declared on January 4, 1996 and payable on January 26, 1996 to
holders of record on January 16, 1996.
On April 3, 1996, the Company's stockholders approved an increase in the number
of authorized shares of common stock from 300,000,000 to 600,000,000.
2. New Accounting Pronouncements
In October 1995, the FASB issued Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), which is
effective for fiscal years beginning after December 15, 1995. SFAS No. 123
encourages, but does not require, companies to record compensation costs for the
fair value of stock-based employee compensation awards, including options. The
Company has elected not to adopt the cost recognition provisions of SFAS No.
123.
In June 1996, the FASB issued Statement of Financial Accounting Standards No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS No. 125"), which is effective for
transactions occurring after December 31, 1996. SFAS No. 125 prescribes the
accounting for the transfer of financial assets, including securitizations,
repurchase and securities lending transactions. The adoption of SFAS No. 125
would not have a material effect on the Company's results of operations. It may,
however, have a material effect on the Consolidated Statement of Financial
Condition of the Company and other companies in the securities industry, but the
effect has not been quantified at this time.
3. Long-Term Borrowings
Long-term borrowings at August 31, 1996 scheduled to mature within one year
aggregate $3,108 million.
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During the nine month period ended August 31, 1996, the Company issued senior
notes aggregating $5,801 million, including non-U.S. dollar currency notes
aggregating $836 million, primarily pursuant to its public debt shelf
registration statements. The weighted average coupon interest rate of these
notes at August 31, 1996 was 5.4%; the Company has entered into certain
transactions to obtain floating interest rates based on either short-term LIBOR
or repurchase agreement rates for Treasury securities. Maturities in the
aggregate of these notes for the fiscal years ending November 30 are as follows:
1997, $592 million; 1998, $1,529 million; 1999, $1,494 million; 2000, $84
million; 2001, $1,558 million; and thereafter, $544 million. As of August 31,
1996, the aggregate outstanding principal amount of the Company's Senior
Indebtedness (as defined in the aforementioned registration statements) was
approximately $22.4 billion.
From September 1, 1996 to September 30, 1996, additional senior notes
aggregating $88 million were issued primarily pursuant to the Company's public
debt shelf registration statements. These notes have maturities from 2001 to
2011.
4. Derivative Contracts and Other Commitments and Contingencies
In the normal course of business, the Company enters into a variety of
derivative contracts related to financial instruments and commodities. The
Company uses swap agreements in its trading activities and in managing its
interest rate exposure. The Company also uses forward and option contracts,
futures and swaps in its trading activities; these financial instruments also
are used to hedge the U.S. dollar cost of certain foreign currency exposures. In
addition, financial futures and forward contracts are actively traded by the
Company and are used to hedge proprietary inventory. The Company also enters
into delayed delivery, when-issued, and warrant and option contracts involving
securities. These instruments generally represent future commitments to swap
interest payment streams, exchange currencies or purchase or sell other
financial instruments on specific terms at specified future dates. Many of these
products have maturities that do not extend beyond one year; swaps and options
and warrants on equities typically have longer maturities. For further
discussion of these matters, refer to "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Derivative Financial
Instruments", and Note 5 to the Consolidated Financial Statements, included in
the Form 10-K.
These derivative instruments involve varying degrees of off-balance sheet market
risk. Future changes in interest rates, foreign currency exchange rates or the
fair values of the financial instruments, commodities or indices underlying
these contracts ultimately may result in cash settlements exceeding fair value
amounts recognized in the Condensed Consolidated Statement of Financial
Condition, which, as described in Note 1, are recorded at fair value,
representing the cost of replacing those instruments.
The Company's exposure to credit risk with respect to these derivative
instruments at any point in time is represented by the fair value of the
contracts reported as assets. These amounts are presented on a
net-by-counterparty basis consistent with FASB Interpretation No. 39, but are
not reported net of collateral, which the Company obtains with respect to
certain of these transactions to reduce its exposure to credit losses.
The credit quality of the Company's trading-related derivatives at August 31,
1996 and November 30, 1995 is summarized in the tables below, showing the fair
value of the related assets by counterparty credit rating. The actual credit
ratings are determined by external rating agencies or by equivalent ratings used
by the Company's Credit Department:
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<TABLE>
<CAPTION>
August 31, 1996
- - -----------------------------------------------------------------------------------------------------------------------------
Collater-
alized Other
Non- Non-
Invest- Invest-
ment ment
(Dollars in millions) AAA AA A BBB Grade Grade Total
- - -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest rate
and currency
swaps and options
(including caps,
floors and swap
options) $ 731 $1,258 $1,495 $ 301 $ 2 $ 164 $3,951
Foreign exchange
forward contracts
and options 511 483 259 12 -- 51 1,316
Mortgage-backed
securities forward
contracts, swaps
and options 97 42 136 18 -- 16 309
Other fixed income
securities contracts
(including options) 8 18 25 5 -- 15 71
Equity securities
contracts
(including equity
swaps, warrants
and options) 505 223 248 136 385 38 1,535
Commodity forwards,
options and swaps 63 241 262 195 -- 302 1,063
------ ------ ------ ------ ------ ------ ------
Total $1,915 $2,265 $2,425 $ 667 $ 387 $ 586 $8,245
====== ====== ====== ====== ====== ====== ======
Percent of total 23% 27% 30% 8% 5% 7% 100%
====== ====== ====== ====== ====== ====== ======
</TABLE>
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<TABLE>
<CAPTION>
November 30, 1995
- - --------------------------------------------------------------------------------------------------------------------------
Collater-
alized Other
Non- Non-
Invest- Invest-
ment ment
(Dollars in millions) AAA AA A BBB Grade Grade Total
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest rate
and currency
swaps and options
(including caps,
floors and swap
options) $ 660 $1,269 $1,148 $ 535 $ 88 $ 141 $3,841
Foreign exchange
forward contracts
and options 548 531 674 83 -- 27 1,863
Mortgage-backed
securities forward
contracts, swaps
and options 23 31 36 7 12 14 123
Other fixed income
securities contracts
(including options) 25 33 33 42 -- 4 137
Equity securities
contracts
(including equity
swaps, warrants
and options) 612 98 232 143 178 159 1,422
Commodity forwards,
options and swaps 103 129 152 126 -- 147 657
------ ------ ------ ------ ------ ------ ------
Total $1,971 $2,091 $2,275 $ 936 $ 278 $ 492 $8,043
====== ====== ====== ====== ====== ====== ======
Percent of total 25% 26% 28% 12% 3% 6% 100%
====== ====== ====== ====== ====== ====== ======
</TABLE>
A substantial portion of the Company's securities and commodities transactions
are collateralized and are executed with and on behalf of commercial banks and
other institutional investors, including other brokers and dealers. Positions
taken and commitments made by the Company, including positions taken and
underwriting and financing commitments made in connection with its merchant
banking and other principal investment activities, often involve substantial
amounts and significant exposure to individual issuers and businesses, including
non-investment grade issuers. The Company seeks to limit concentration risk
created in its businesses through a variety of separate but complementary
financial, position and credit exposure reporting systems, including the use of
trading limits based in part upon the Company's review of the financial
condition and credit ratings of its counterparties.
See also "Business -- Risk Management" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Risk Management" in the Form
10-K for discussions of the Company's risk management policies and procedures.
The Company had approximately $3.0 billion of letters of credit outstanding at
August 31, 1996 to satisfy various collateral requirements.
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The Company and its subsidiaries have been named as defendants in certain legal
actions and have been involved in certain investigations and proceedings in the
ordinary course of business. It is the opinion of management, based on current
knowledge and after consultation with counsel, that the outcome of such matters
will not have a material adverse effect on the Company's Condensed Consolidated
Financial Statements contained herein.
5. Preferred Stock
Preferred stock is composed of the following issues. Each issue of preferred
stock ranks in parity with all other preferred stock.
<TABLE>
<CAPTION>
Shares Outstanding at Balance at
-------------------------------- ---------------------------------
August 31, November 30, August 31, November 30,
1996 1995 1996 1995
--------------- --------------- --------------- ---------------
(in millions)
<S> <C> <C> <C> <C>
ESOP Convertible
Preferred Stock,
liquidation preference
$35.88 3,711,165 3,758,133 $ 133 $ 135
9.36% Cumulative
Preferred Stock,
stated value $25 - 5,500,000 - 138
7-3/8% Cumulative
Preferred Stock,
stated value $200 1,000,000 1,000,000 200 200
8.88% Cumulative
Preferred Stock,
stated value $200 975,000 975,000 195 195
8-3/4% Cumulative
Preferred Stock,
stated value $200 750,000 750,000 150 150
7-3/4% Cumulative
Preferred Stock,
stated value $200 1,000,000 - 200 -
------ ------
Total $ 878 $ 818
====== ======
</TABLE>
On May 23, 1996, the Company announced that it had called for redemption, on
June 24, 1996, all 5,500,000 shares of its 9.36% Cumulative Preferred Stock at a
redemption price of $25.156 per share, which reflects the stated value of $25
per share together with an amount equal to all dividends accrued and unpaid to,
but excluding, June 24, 1996.
On July 22, 1996, the Company issued 4,000,000 Depositary Shares, representing
1,000,000 shares of 7-3/4% Cumulative Preferred Stock, in an aggregate amount of
$200 million. Each Depositary Share represents 1/4 of a share of such preferred
stock.
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6. Stockholders' Equity
Morgan Stanley & Co. Incorporated ("MS&Co.") is a registered broker-dealer and
a registered futures commission merchant and, accordingly, is subject to the
minimum net capital requirements of the Securities and Exchange Commission, the
New York Stock Exchange and the Commodity Futures Trading Commission. MS&Co. has
consistently operated in excess of these requirements with aggregate net
capital, as defined, totaling $1,172 million at August 31, 1996, which exceeded
the amount required by $929 million. Morgan Stanley & Co. International Limited
("MSIL"), a London-based broker-dealer subsidiary, is subject to capital
requirements of the Securities and Futures Authority, and Morgan Stanley Japan
Limited ("MSJL"), a Tokyo-based broker-dealer, is subject to the capital
requirements of the Japanese Ministry of Finance. MSIL and MSJL have
consistently operated in excess of their respective regulatory capital
requirements.
Certain other U.S. and non-U.S. subsidiaries are subject to various securities,
commodities and banking regulations, and capital adequacy requirements
promulgated by the regulatory and exchange authorities of the countries in which
they operate. These subsidiaries have consistently operated in excess of their
applicable local capital adequacy requirements.
7. Miller Anderson & Sherrerd, LLP ("MAS")
During the first quarter of fiscal 1996, the Company completed its acquisition
of MAS, a Philadelphia-based investment manager, for approximately $350 million.
The goodwill associated with this transaction is being amortized on a
straight-line basis over 25 years. The Company's results for the nine months
ended August 31, 1996 include the results of MAS since January 3, 1996, the date
of acquisition.
8. Van Kampen American Capital, Inc.
The Company announced on June 24, 1996 that it had signed a definitive agreement
to purchase VK/AC Holding, Inc. ("VKAC"), the parent of Van Kampen American
Capital, Inc. ("Van Kampen"), for $745 million. Van Kampen is the fourth largest
non-proprietary mutual fund provider in the United States with more than $57
billion in assets under management or supervision. The consideration for the
purchase of the equity of VKAC will consist of cash and $25 million of preferred
securities exchangeable into common stock of the Company. As of August 31, 1996,
VKAC had long-term debt outstanding of approximately $400 million. The
acquisition is expected to close in the fourth quarter of fiscal 1996 and is
subject to customary closing conditions. The acquisition will be accounted for
as a purchase.
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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS *
Results of Operations
The Company's business, particularly its involvement in primary and secondary
markets for all types of financial products, including derivatives, is subject
to substantial positive and negative fluctuations due to a variety of factors
that cannot be predicted with great certainty, including variations in the fair
value of securities and other financial products, the volatility and liquidity
of trading markets, and the level of market activity. As a result, net income
and revenues in any particular period may not be representative of full-year
results and may vary significantly from year to year and from quarter to
quarter. In addition, results of operations in the past have been and in the
future may continue to be materially affected by many factors of a national and
international nature, including economic and market conditions; the availability
of capital; the level and volatility of interest rates; currency values and
other market indices; the availability of credit; inflation; and legislative and
regulatory developments, as well as the size, number and timing of transactions
or assignments (including realization of returns from the Company's principal
and merchant banking investments). In addition, such factors also may have an
impact on the Company's ability to achieve its strategic objectives, including
(without limitation) profitable global expansion. The Company's results of
operations also may be materially affected by competitive factors, including new
entrants into the Company's traditional business activities and its ability to
attract and retain highly skilled individuals and by the ability to
cost-effectively develop and maintain the technology necessary to support its
trading, clearing and risk management systems.
The market conditions which characterized the first half of fiscal 1996 were not
as favorable during the third quarter, resulting in lower levels of net revenues
and earnings for the Company as compared to the record levels of the first and
second quarters of fiscal 1996. Investors became defensive as a result of
concerns regarding higher interest rates, modest corporate earnings growth and
expectations of higher inflation. Additionally, the amount of money flowing into
stock mutual funds fell as July infusions reflected the lowest level in almost
two years. Seasonal factors also had an impact on the business environment, as
the late summer months are generally characterized by lower levels of activity
in the global capital markets. Despite these less favorable market conditions,
which resulted in slower client-driven trading, periods of lower market
volatility and a decline in underwriting activity, the Company achieved higher
revenues in the third quarter of fiscal 1996 than in the comparable prior year
quarter, reflecting, in part, the balanced mix of its global core businesses -
investment banking, asset management and sales and trading.
____________________
* Except for the historical information contained herein, this Management's
Discussion and Analysis of Financial Condition and Results of Operations
contains forward-looking statements that could be affected by the risks and
uncertainties involved in the Company's business, including (without
limitation) the risks and uncertainties set forth herein and in the Company's
Annual Report on Form 10-K for the fiscal period ended November 30, 1995
(Part I, Item 1 and Part II, Item 7).
Page 15
<PAGE> 16
Consistent with the Company's long-term strategic goal of expanding recurring
fee-based revenues, the Company announced on June 24, 1996 that it had signed a
definitive agreement to purchase VK/AC Holding, Inc. ("VKAC"), the parent of Van
Kampen American Capital, Inc. ("Van Kampen"), for $745 million. Van Kampen is
the fourth largest non-proprietary mutual fund provider in the United States
with more than $57 billion in assets under management or supervision. The
consideration for the purchase of the equity of VKAC will consist of cash and
$25 million of preferred securities exchangeable into common stock of the
Company. As of August 31, 1996, VKAC had long-term debt outstanding of
approximately $400 million. To the extent that operating cash flow between
signing and closing permits paydown of such long-term debt, the purchase price
of the equity will be increased, but in no circumstances will the sum of the
equity purchase price and the remaining long-term debt exceed $1.175 billion.
The acquisition is expected to close in the fourth quarter of fiscal 1996 and is
subject to customary closing conditions. Including VKAC and Miller Anderson &
Sherrerd, LLP ("MAS"), an institutional investment management firm acquired by
the Company in January 1996, the Company's asset management division will manage
assets totaling approximately $160 billion on a pro forma basis.
For a description of the Company's business, including its trading in cash
instruments and derivative products, its merchant banking and other principal
investment activities, and its high-yield underwriting and trading policies, and
their respective risks, and the Company's risk management policies and
procedures, see Part I, Item 1, of the Company's Annual Report on Form 10-K for
the fiscal period ended November 30, 1995 ("Form 10-K").
In February 1995, the Board of Directors approved a change in the Company's
fiscal year-end from January 31 to November 30, effective for the fiscal period
ended November 30, 1995. The discussion which follows compares the results of
operations for the three and nine months ended August 31, 1996 to the three and
nine months ended August 31, 1995. Due to the Company's change in fiscal
year-end, the results for the nine months ended August 31, 1995 includes the
final two months of fiscal 1994 (December 1994 and January 1995) and the first
seven months of fiscal 1995.
Three Months Ended August 31, 1996 Compared with Three Months Ended August 31,
1995
(Amounts for the three months ended August 31, 1995 are given in parentheses).
Revenues net of interest expense (net revenues) were $1,287 million ($1,151
million) and net income totaled $219 million ($209 million), primarily
reflecting higher levels of investment banking revenues and increased principal
transaction trading revenues, partially offset by higher incentive-based
compensation. The quarter's financial results also benefited from a reduction in
the Company's year-to-date effective income tax rate from 36% to 34.5%. Lower
taxes applicable to non-U.S. earnings contributed to the decline in the income
tax rate.
Investment banking revenues increased to $431 million ($355 million), reflecting
another strong quarter, surpassed only by the fourth quarter of fiscal 1995 and
the second quarter of fiscal 1996. Revenues from merger, acquisition and
restructuring activities increased, benefiting from transaction volumes which
continued to remain strong industry-wide, coupled with the Company's strong
global presence. Fees from real estate transactions also increased as compared
to the prior year quarter. Equity underwriting revenues also increased, although
the primary calendar demonstrated lower volumes as compared to the second
quarter of fiscal 1996. Fixed income revenues were comparable to prior year
levels, as higher revenues from global high-yield debt issuances were offset by
a decline in corporate debt financings.
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Secondary revenues (combined principal trading, commissions and net interest
revenues) increased to $690 million ($630 million). Principal transaction
revenues from trading activities, including derivatives, were $427 million ($352
million). Equity trading revenues increased, reflecting higher revenues from
both cash and derivative products primarily due to the existence of more
favorable market conditions as compared to the prior year. Equity cash products
were positively affected by higher levels of infusions into mutual funds, and
equity derivatives revenues increased as higher levels of volatility in the U.S.
markets led to heightened trading activity in these products. Fixed income
trading revenues declined from prior year levels, principally reflecting a
decrease in revenues from government debt trading. Results were adversely
impacted by strong labor market data which increased concern of higher inflation
in the U.S., resulting in a decline of customer trading volume and periods of
lower market volatility. These declines were partially offset by higher revenues
from securitized debt and high-yield trading activities. Commodities trading
revenues rose substantially, reflecting increased revenues from oil and refined
energy products. Volatility in these market segments increased as a result of
continued uncertainty over Iraq's reentry into the world crude oil markets as
well as increased unrest in the Middle East. Revenues from foreign exchange
trading were comparable to prior year levels as market volatility remained
relatively low, with the exception of mid-July when the U.S. dollar fell against
most major currencies as a result of a dramatic decline in the U.S. stock
market.
Principal transaction investment gains aggregating $29 million ($69 million)
were recognized in the third quarter of fiscal 1996, primarily in connection
with increases in the carrying value of certain merchant banking investments.
Commission revenues increased to $148 million ($130 million), principally
reflecting heightened customer demand for derivative products, including equity
options and futures, resulting from increased market volatility as compared to
the prior year, as well as continued cash flows into the equity markets from
institutional investors.
Net interest and dividend revenues decreased to $115 million ($148 million).
Interest and dividend revenues rose to $2,144 million ($1,899 million), and
interest and dividend expense increased to $2,029 million ($1,751 million),
principally reflecting growth in interest-bearing assets and liabilities.
Interest and dividend revenues and expense are a function of the level and mix
of total assets, including financial instruments owned and resale and repurchase
agreements, and the prevailing level, term structure and volatility of interest
rates. Interest and dividend revenues and expense should be viewed in the
broader context of principal trading and investment banking results. Decisions
relating to principal transactions in securities are based on an overall review
of aggregate revenues and costs associated with each transaction or series of
transactions. This review includes an assessment of the potential gain or loss
associated with a trade, the interest income or expense associated with
financing or hedging the Company's positions, and potential underwriting,
commission or other revenues associated with related primary or secondary market
sales.
Page 17
<PAGE> 18
Asset management and administration revenues, which include fees for asset
management and non-interest revenues earned from correspondent clearing and
custody services, increased to $137 million ($96 million), primarily reflecting
contributions from MAS. The remaining increase was principally due to the
continued strong performance of revenues from international equity and emerging
market products resulting from inflows of client assets and market appreciation,
partially offset by a decline in revenues from domestic equity products.
Customer assets under management increased to $102 billion ($52 billion),
including $36 billion associated with the acquisition of MAS as well as
continued inflows of new assets and appreciation in the value of existing
customer portfolios. Customer assets under administration increased to $132
billion ($109 billion), primarily reflecting appreciation in the value of
customer portfolios, as well as additional assets placed under custody with the
Company.
Total expenses excluding interest increased to $972 million ($853 million).
Within that total, compensation and benefits expense increased $70 million to
$645 million ($575 million), principally reflecting increased levels of
incentive compensation based on higher levels of revenues and earnings.
Non-compensation expenses, excluding brokerage, clearing and exchange fees,
increased $48 million to $262 million. Occupancy and equipment expenses
increased $5 million, primarily related to increased costs associated with the
Company's move to 1585 Broadway, new leased office space in Tokyo and occupancy
costs of MAS. Business development expenses increased $7 million, reflecting
increased travel and entertainment costs as the Company continues to develop new
business. Professional services expenses increased $21 million, primarily
reflecting higher consulting and executive recruitment costs associated with the
Company's increased global business activities. Communications expenses
increased $7 million, primarily due to the impact of increased global business
activity and additional employees hired during fiscal 1996. Other expenses
increased $8 million, primarily attributable to the amortization of goodwill
associated with the acquisition of MAS.
A portion of the increase in non-compensation expenses is due to significantly
higher overall levels of business activity as compared to the prior year
quarter. The Company continuously monitors these expenses in order to control
the level of discretionary spending.
Nine Months Ended August 31, 1996 Compared with Nine Months Ended August 31,
1995
(Amounts for the nine months ended August 31, 1995 are given in parentheses).
Revenues net of interest expense (net revenues) were $4,264 million ($2,955
million), and net income totaled $793 million ($422 million), reflecting
increased revenues among all three of the Company's core businesses - investment
banking, asset management and sales and trading - partially offset by higher
incentive-based compensation.
Investment banking revenues increased to $1,372 million ($871 million)
reflecting significantly higher levels of merger, acquisition and restructuring
revenues as well as increased equity and debt underwriting revenues, resulting
from a higher level of equity and debt financing activity due to more favorable
market conditions. Revenues from real estate transactions also increased as
compared to the prior year period.
Page 18
<PAGE> 19
Secondary revenues (combined principal trading, commissions and net interest
revenues) increased to $2,427 million ($1,723 million). Principal transaction
revenues from trading activities were $1,696 million ($989 million), reflecting
substantially higher revenues from trading in equity and fixed income products,
including derivative related products. Equity trading revenues were
substantially higher, driven by strong revenues across all business product
lines. Higher trading volumes and customer demand, significant infusions of cash
into mutual funds and increased market volatility positively impacted trading
revenues. Fixed income trading revenues were also substantially higher,
including improved trading revenues from emerging market and high-yield
activities as economic conditions stabilized globally, including in Mexico and
certain emerging markets. Commodities trading revenues also increased
significantly, reflecting higher revenues from crude oil and refined energy
products due to higher volatility in these market segments. Revenues from
foreign exchange trading decreased due to lower volatility in the markets for
major currencies.
Principal transaction investment revenues aggregating $60 million ($82 million)
were recognized during the nine month period ended August 31, 1996, primarily
reflecting revenues related to the increase in carrying value of certain of the
Company's merchant banking investments.
Commission revenues increased to $461 million ($372 million), principally
reflecting increased customer activity in the global markets for equity
securities, including revenues related to a strong primary calendar in the U.S.
and Europe as well as increased inflows of funds from institutional investors.
Net interest and dividend revenues were $270 million ($362 million). Interest
and dividend revenues rose to $6,023 million ($5,501 million) and interest
expense increased to $5,753 million ($5,139 million). As noted in the quarter to
quarter comparison of net interest, interest and dividend revenues and expense
reflect principal trading strategies and should be viewed in the broader context
of principal trading and investment banking results.
Asset management and administration revenues increased to $402 million ($275
million), primarily attributable to revenues associated with MAS, as well as
increased revenues in international equity and emerging markets products and
continued growth in customer assets under management and administration.
Total expenses excluding interest increased to $3,053 million ($2,334 million).
Within that total, employee compensation and benefits expense increased to
$2,100 million ($1,416 million), principally reflecting increased levels of
incentive compensation based on higher revenues and earnings. Non-compensation
expenses, excluding brokerage, clearing and exchange fees and fiscal 1994's $59
million relocation charge, increased to $754 million ($674 million). Brokerage,
clearing and exchange fees increased $14 million, reflecting increased
securities trading volumes. Professional services expenses increased $32
million, reflecting higher consulting costs and executive recruitment costs as a
result of the increased level of overall business activity. Occupancy and
equipment expense increased $14 million, reflecting increased costs associated
with the Company's move to 1585 Broadway, new leased office space in Tokyo and
the occupancy costs of MAS. Other expenses increased by $19 million primarily as
a result of goodwill amortization associated with the acquisition of MAS, as
well as the increase in the overall level of business activity.
Page 19
<PAGE> 20
Liquidity and Capital Resources
The Company's total assets increased from $143.8 billion at November 30, 1995 to
$169.2 billion at August 31, 1996, primarily reflecting growth in resale
agreements and securities borrowed. A substantial portion of the Company's total
assets consists of highly liquid marketable securities and short-term
receivables arising principally from securities transactions. The highly liquid
nature of these assets provides the Company with flexibility in financing and
managing its business. Balance sheet leverage ratios are often reviewed by
counterparties and creditors in order to evaluate a securities firm's overall
financial risk. Details of ending assets, month-end average assets and leverage
ratios for the nine months ended August 31, 1996 and for fiscal 1995 are as
follows:
<TABLE>
<CAPTION>
Average Assets
for the
Assets at Nine Months Ended Assets at Average Assets
(Dollars in Millions) August 31, 1996 August 31, 1996 November 30, 1995 for Fiscal 1995
- - --------------------- --------------- ------------------ ----------------- ---------------
<S> <C> <C> <C> <C>
Cash, deposits and receivables $ 14,957 $ 14,963 $ 10,286 $ 12,690
Financial instruments owned 55,170 59,388 58,600 52,387
Securities purchased under
agreements to resell and
securities borrowed 96,696 91,001 72,955 66,539
Property, equipment and
leasehold improvements and
other assets 2,403 2,398 1,912 1,725
-------- -------- -------- --------
Total assets $169,226 $167,750 $143,753 $133,341
======== ======== ======== ========
Leverage ratios:
Total assets/equity 30.6x 31.9x 27.8x 27.8x
Net assets(1)/equity 19.5x 21.0x 18.9x 18.6x
</TABLE>
- - -------------
(1) Net assets represent total assets less the lower of securities purchased
under agreements to resell or securities sold under agreements to
repurchase.
The Company's Finance and Risk Committee, which includes senior officers from
each of the major capital commitment areas, among other things, establishes the
overall funding and capital policies of the Company, reviews the Company's
performance relative to these policies, allocates capital among business
activities of the Company, monitors the availability of sources of financing,
reviews the foreign exchange risk of the Company, and oversees the liquidity and
interest rate sensitivity of the Company's asset and liability position. The
primary goal of the Company's funding and liquidity activities is to ensure the
stability of the Company's funding base and provide adequate financing sources
over a wide range of potential credit ratings and market environments.
The Company actively manages its consolidated capital position based upon, among
other things, business opportunities, capital availability and rates of return
together with internal capital policies, regulatory requirements and rating
agency guidelines and, therefore, may in the future expand or contract its
capital base to address the changing needs of its businesses. The Company
returns internally generated equity capital which is in excess of the needs of
its businesses through common stock repurchases and dividends.
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<PAGE> 21
The Company funds its balance sheet on a global basis. The Company's funding
needs are satisfied from capital, including equity and long-term debt;
medium-term notes; internally generated funds; repurchase agreements; U.S.,
Canadian, French and Euro commercial paper; German Schuldschein loans;
securities lending; buy/sell agreements; municipal re-investments; master notes;
deposits; and committed and uncommitted lines of credit. All repurchase
transactions and a portion of the Company's bank borrowings are made on a
collateralized basis.
The Company maintains borrowing relationships with a broad range of banks,
financial institutions, counterparties and others from which it draws funds in a
variety of currencies. The volume of the Company's borrowings generally
fluctuates in response to changes in the amount of resale transactions
outstanding, the level of the Company's securities inventories and overall
market conditions. Availability and cost of financing to the Company can vary
depending upon market conditions, the volume of certain trading activities, the
Company's credit ratings and the overall availability of credit to the
securities industry.
The Company's reliance on external sources to finance a significant portion of
its day-to-day operations makes access to global sources of financing important.
The cost of such financing is generally dependent on the Company's short-term
and long-term debt ratings. In addition, the Company's debt ratings have a
significant impact on certain trading revenues, particularly in those businesses
where longer term counterparty performance is critical, such as over-the-counter
derivative transactions. The Company's short-term and long-term senior debt
ratings as of August 31, 1996 are as follows:
<TABLE>
<CAPTION>
Agency Short-Term Rating Long-Term Rating
- - ------ ----------------- ----------------
<S> <C> <C>
Moody's Investors Service P1 A1
Standard & Poor's A1+ A+
IBCA A1+ AA-
Thomson BankWatch TBW1 AA
Dominion Bond Rating Service(1) R1 (Middle) n/a
</TABLE>
- - ---------
(1) Dominion Bond Rating Service rates the Company's Canadian commercial
paper program.
As the Company continues its global expansion and as revenues are increasingly
derived from various currencies, foreign currency management is a key element of
the Company's financial policies. The Company benefits from operating in a
number of different currencies because weakness in any particular currency is
often offset by strength in another currency. The Company closely monitors its
exposure to fluctuations in currencies and, where cost-justified, adopts
strategies to reduce the impact of these fluctuations on the Company's financial
performance. These strategies include engaging in various hedging activities to
manage income and cash flows denominated in foreign currencies and using foreign
currency borrowings, when appropriate, to finance investments outside the U.S.
During the nine month period ended August 31, 1996, the Company issued senior
notes aggregating $5,801 million, including non-U.S. dollar currency notes
aggregating $836 million. These notes have maturities from 1997 to 2011 and a
weighted average coupon interest rate of 5.4%. As of August 31, 1996, the
aggregate outstanding principal amount of the Company's Senior Indebtedness (as
defined in the Company's public debt shelf registration statements) was
approximately $22.4 billion. During the second quarter of fiscal 1996, the
Company filed a shelf registration statement for the issuance of up to $4,286
million of debt securities, warrants to purchase debt securities, or preferred
stock.
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<PAGE> 22
Between September 1, 1996 and September 30, 1996, additional senior notes
aggregating $88 million were issued. These notes have maturities from 2001 to
2011.
The Company maintains a senior revolving credit facility with a group of banks.
Under the terms of the credit agreement, the banks are committed to provide up
to $2.5 billion for up to 364 days. Any loans outstanding on the commitment
termination date will mature on the first anniversary of the commitment
termination date.
The Company also maintains a master collateral facility that enables Morgan
Stanley & Co. Incorporated ("MS&Co."), the Company's U.S. broker-dealer
subsidiary, to pledge certain collateral to secure loan arrangements, letters of
credit and other financial accommodations. As part of this facility, MS&Co. also
maintains a secured committed credit agreement with a group of banks that are
parties to the master collateral facility under which such banks are committed
to provide up to $1.25 billion for up to 364 days. Any loans outstanding on the
commitment termination date will mature on the first anniversary of the
commitment termination date.
In December, 1995, the Company established a revolving committed financing
facility that enables Morgan Stanley & Co. International Limited ("MSIL"), the
Company's U.K. broker-dealer subsidiary, to secure committed funding from a
syndicate of banks by providing a broad range of collateral under repurchase
agreements. Such banks are committed to provide up to an aggregate of $1.25
billion available in twelve major currencies for up to 364 days. Any amounts
outstanding on the commitment termination date may, at MSIL's option, be
extended to mature on or before the first anniversary of the commitment
termination date.
There were no borrowings outstanding under any of the foregoing credit,
collateral or committed financing facilities at August 31, 1996; however, the
Company anticipates utilizing these facilities for short-term funding from time
to time.
On May 23, 1996, the Company announced that it had called for redemption, on
June 24, 1996, all 5,500,000 shares of its 9.36% Cumulative Preferred Stock at a
redemption price of $25.156 per share, which reflects the stated value of $25
per share together with an amount equal to all dividends accrued and unpaid to,
but excluding, June 24, 1996. On July 17, 1996, the Company issued 4,000,000
Depositary Shares, representing 1,000,000 shares of 7 3/4% Cumulative Preferred
Stock, in an aggregate amount of $200 million. Each Depositary Share represents
1/4 of a share of such preferred stock.
During the nine month period ended August 31, 1996, the Company repurchased
approximately 11 million shares of its common stock at an aggregate cost of
approximately $507 million. On March 27, 1996, the Board of Directors authorized
the purchase, in the open market or otherwise, subject to market conditions and
certain other factors, of an additional $150 million of the Company's common
stock. The unused portion of the Company's stock repurchase authorization at
September 30, 1996 was approximately $258 million.
Certain assets of the Company, such as real property, equipment, leasehold
improvements, certain equity investments made in connection with the Company's
merchant banking and other principal investment activities, and certain
high-yield debt securities, emerging market debt and collateralized mortgage
obligations and mortgage-related loan products, are not highly liquid. In
connection with its merchant banking and other principal investment activities,
the Company has equity investments (directly and indirectly through funds
managed by the Company) in privately or publicly held companies. As of August
31, 1996, the aggregate carrying value of the Company's equity investments
(including direct investments and partnership interests) in privately held
companies was $91 million, and its aggregate investment in publicly held
companies was $320 million.
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<PAGE> 23
In its capacity as an underwriter of and a market-maker in mortgage-backed
securities, collateralized mortgage obligations and related instruments, and a
market-maker in commercial, residential and real estate loan products, the
Company takes positions in market segments where liquidity can vary greatly from
time to time. The carrying value of such financial instruments traded in markets
currently experiencing lower levels of liquidity approximated $1,270 million at
August 31, 1996.
In addition, at August 31, 1996, the aggregate value of high-yield debt
securities and emerging market loans and securitized instruments held in
inventory was $1,397 million (a substantial portion of which was subordinated
debt) with not more than 5%, 10% and 13% of all such securities, loans and
instruments attributable to any one issuer, industry or geographic region,
respectively. Non-investment grade securities generally involve greater risk
than investment grade securities due to the lower credit ratings of the issuers,
which typically have relatively high levels of indebtedness and are, therefore,
more sensitive to adverse economic conditions. In addition, the market for
non-investment grade securities and emerging markets loans and securitized
instruments has been, and may in the future be, characterized by periods of
volatility and illiquidity. The Company has in place credit and other risk
policies and procedures to control total inventory positions and risk
concentrations for non-investment grade securities and emerging market loans and
securitized instruments.
The Company may, from time to time, also provide financing or financing
commitments to companies in connection with its investment banking activities
that may subject the Company to increased credit and liquidity risks. Subsequent
to August 31, 1996, the Company entered into one commitment to provide $30
million of interim financing as part of a $90 million commitment made by certain
members of the Morgan Stanley Bridge Fund, LLC. The Company also engages in
senior lending activities, including origination, syndication and trading of
senior secured loans of non-investment grade companies. As of August 31, 1996,
the aggregate value of senior secured loans and positions held by the Company
was $172 million and aggregate senior secured loan commitments were $30 million.
Subsequent to August 31, 1996, the Company entered into three senior secured
loan commitments in the aggregate amount of $344 million.
At August 31, 1996, financial instruments owned by the Company included
derivative products (generally in the form of futures, forwards, swaps, caps,
collars, floors, swap options and similar instruments which derive their value
from underlying interest rates, foreign exchange rates or commodity or equity
instruments and indices) related to financial instruments and commodities with
an aggregate net replacement cost of $8.2 billion. The net replacement cost of
all derivative products in a gain position represents the Company's maximum
exposure to derivatives related credit risk. Derivative products may have both
on- and off-balance sheet risk implications, depending on the nature of the
contract. It should be noted, however, that in many cases derivatives serve to
reduce, rather than increase, the Company's exposure to losses from market,
credit and other risks. The risks associated with the Company's derivative
activities, including market and credit risks, are managed on an integrated
basis with associated cash instruments in a manner consistent with the Company's
overall risk management policies and procedures. The Company manages its
exposure to derivative products through various means, which include monitoring
the creditworthiness of counterparties and credit limits on an ongoing basis;
entering into master netting agreements and collateral arrangements with
counterparties in appropriate circumstances; and limiting the duration of
exposure.
Page 23
<PAGE> 24
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
(a) The following matter was recently commenced against Morgan
Stanley & Co. Incorporated ("Morgan Stanley").
Department of Justice NASDAQ Investigation. On July 17, 1996, Morgan
Stanley and 23 other dealers who make markets in securities traded on NASDAQ
entered into a stipulation and order with the United States Department of
Justice which simultaneously filed a civil complaint in the United States
District Court for the Southern District of New York alleging that the 24 market
makers had violated section 1 of the Sherman Act. The complaint asserts, and
Morgan Stanley denies, that the various market makers had entered into a
so-called "quoting convention" under which the market makers avoided the use of
odd-eighth quotes when the spread between the bid and ask price was at least
3/4. The stipulation and order commits the 24 market makers to avoid engaging in
certain practices which could support the existence of a purported "quoting
convention" and to adopt various procedures to assure compliance with their
agreement. The stipulation and order is subject to court approval and, if
approved, will result in the dismissal of the complaint.
(b) The following developments have occurred with respect to certain
matters previously reported in the Form 10-K and/or the Company's Quarterly
Reports on Form 10-Q for the fiscal quarters ended February 29, 1996 and May 31,
1996.
State of West Virginia v. Morgan Stanley & Co. Incorporated. The
action has been settled.
Atwood, et al. v. Burlington Industries Equity, Inc., et al. The
action has been settled.
Hedged - Investments Litigation. On April 26, 1996, the class member
filed a petition for a writ of certiorari with the Colorado Supreme Court, which
was denied on August 19, 1996.
ITEM 2. CHANGES IN SECURITIES.
On July 17, 1996, the Company issued 4,000,000 Depositary Shares,
representing 1,000,000 shares of its 7 3/4% Cumulative Preferred Stock. Exhibit
4 to this Form 10-Q sets forth the designation, preferences and rights of the 7
3/4% Cumulative Preferred Stock and the following summary is qualified in its
entirety by reference thereto.
The 7 3/4% Cumulative Preferred Stock ranks as to payment of
dividends and amounts payable on liquidation prior to the Company's Common Stock
and on a parity with the Company's ESOP Convertible Preferred Stock, 9.36%
Cumulative Preferred Stock,* 8.88% Cumulative Preferred Stock, 8 3/4% Cumulative
Preferred Stock and 7 3/8% Cumulative Preferred Stock. The holders of the 7 3/4%
Cumulative Preferred Stock are entitled to receive, when declared out of funds
legally available therefor, cash dividends payable quarterly at the rate of
7 3/4% per annum, calculated as a percentage of the stated value.
If amendments to the Internal Revenue Code of 1986, as amended (the
"Code") are enacted that reduce the percentage of the dividends received
deduction as specified in Section 243(a)(1) of the Code (the "Dividends Received
Percentage") to below 70%, the amount of each dividend payable on the 7 3/4%
Cumulative Preferred Stock made on or after the date
__________
*All 5,500,000 shares of 9.36% Cumulative Preferred Stock were called for
redemption on May 23, 1996 and redeemed on June 24, 1996. No shares of 9.36%
Cumulative Preferred Stock are outstanding.
Page 24
<PAGE> 25
of such amendment will be adjusted in accordance with the dividends received
deduction formula set forth in Exhibit 4 to this Form 10-Q.
Unless full cumulative dividends on the 7 3/4% Cumulative Preferred
Stock have been paid, dividends (other than in Common Stock) may not be paid or
declared and set aside for payment and other distributions may not be made upon
the Common Stock or on any other Preferred Stock of the Company ranking junior
to or on a parity with the 7 3/4% Cumulative Preferred Stock as to dividends,
nor may any Common Stock or such other Preferred Stock of the Company be
redeemed, purchased or otherwise acquired by the Company for any consideration
or any payment be made to or available for a sinking fund for the redemption of
any shares of such stock.
In the event of any liquidation, dissolution or winding up of the
Company, the holders of shares of 7 3/4% Cumulative Preferred Stock will be
entitled to receive (out of assets of the Company available for distribution to
stockholders) liquidating distributions in the amount of $200.00 per share
(equivalent to $50.00 per Depositary Share), plus accrued and accumulated but
unpaid dividends to the date of final distribution, before any distribution is
made to holders of Common Stock.
Holders of 7 3/4% Cumulative Preferred Stock will have voting rights
only as required by the laws of the State of Delaware or whenever dividends
payable on the 7 3/4% Cumulative Preferred Stock or any other class or series of
stock ranking on a parity with the 7 3/4% Cumulative Preferred Stock with
respect to the payment of dividends are in arrears for any aggregate number of
days equal to six calendar quarters or more, whether or not consecutive. In this
case, each holder of 7 3/4% Cumulative Preferred Stock will be entitled to one
vote for each share of 7 3/4% Cumulative Preferred Stock held (voting together
as a class with all other series of the Company's Preferred Stock upon which
like voting rights have been conferred and are exercisable) to elect two
directors of the Company at the next annual meeting of stockholders and at each
subsequent meeting until such arrears have been fully paid or set apart for
payment.
The 7 3/4% Cumulative Preferred Stock is redeemable in whole or in
part at the Company's option on or after August 30, 2001, at a redemption price
equal to $200.00 per share (equivalent to $50.00 per Depositary Share), plus
accrued and accumulated but unpaid dividends. If full cumulative dividends on
the 7 3/4% Cumulative Preferred Stock have not been paid, the 7 3/4% Cumulative
Preferred Stock may not be redeemed in part and the Company may not purchase or
acquire any shares of 7 3/4% Cumulative Preferred Stock other than pursuant to a
purchase or exchange offer made on the same terms to all holders of the 7 3/4%
Cumulative Preferred Stock.
Prior to August 30, 2001, if the Dividends Received Percentage is
reduced to 40% or less, the Company may at its option redeem all, but not less
than all, of the 7 3/4% Cumulative Preferred Stock at the applicable redemption
price set forth in Exhibit 4 to this Form 10-Q, plus accrued and accumulated but
unpaid dividends.
Page 25
<PAGE> 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
<TABLE>
<S> <C>
(a) Exhibits
Exhibit 4 - Restated Certificate of Incorporation, as amended to
date (previously filed as an exhibit to the Company's
Current Report on Form 8-K dated July 17, 1996 and
incorporated herein by this reference).
Exhibit 11 - Statement Re: Computation of Earnings per Share.
Exhibit 12 - Statement Re: Computation of Ratio of Earnings to Fixed
Charges and Preferred Stock Dividends.
Exhibit 27 - Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K
1. Form 8-K dated June 14, 1996, Item 7 only.
2. Form 8-K dated June 24, 1996, Items 5 and 7.
3. Form 8-K dated June 26, 1996, Item 7 only.
4. Form 8-K dated July 2, 1996, Items 5 and 7.
5. Form 8-K dated July 17, 1996, Item 7 only.
6. Form 8-K dated July 24, 1996, Item 7 only.
7. Form 8-K dated August 12, 1996, Item 7 only.
8. Form 8-K dated August 23, 1996, Items 5 and 7.
Page 26
<PAGE> 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MORGAN STANLEY GROUP INC.
Registrant
Date: October 11, 1996 /s/ Eileen K. Murray
---------------------
Eileen K. Murray
Treasurer and Chief Accounting Officer
Date: October 11, 1996 /s/ Jonathan M. Clark
----------------------
Jonathan M. Clark
General Counsel and Secretary
Page 27
<PAGE> 28
EXHIBIT INDEX
<TABLE>
<S> <C>
(a) Exhibits
Exhibit 4 - Restated Certificate of Incorporation, as amended to
date (previously filed as an exhibit to the Company's
Current Report on Form 8-K dated July 17, 1996 and
incorporated herein by this reference).
Exhibit 11 - Statement Re: Computation of Earnings per Share.
Exhibit 12 - Statement Re: Computation of Ratio of Earnings to Fixed
Charges and Preferred Stock Dividends.
Exhibit 27 - Financial Data Schedule.
</TABLE>
<PAGE> 1
Exhibit 11
MORGAN STANLEY GROUP INC.
COMPUTATION OF EARNINGS PER SHARE
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------ ------------------------------
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
1996 1995 (1) 1996 1995 (1)
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
PRIMARY:
Common stock and common stock equivalents:
Average common shares outstanding 152,196,305 154,423,260 153,049,188 153,248,080
Average common shares issuable
under employee benefit plans 1,837,928 2,813,658 2,256,346 2,000,994
------------ ------------ ------------ ------------
Total average common and common
equivalent shares outstanding 154,034,233 157,236,918 155,305,534 155,249,074
============ ============ ============ ============
Earnings:
Net income $ 219 $ 209 $ 793 $ 422
Less: Preferred stock dividend
requirements 15 17 48 49
------------ ------------ ------------ ------------
Earnings applicable to common shares $ 204 $ 192 $ 745 $ 373
============ ============ ============ ============
Primary earnings per share $ 1.32 $ 1.23 $ 4.79 $ 2.41
============ ============ ============ ============
FULLY DILUTED:
Common stock and common stock equivalents:
Average common shares outstanding 152,196,305 154,423,260 153,049,188 153,248,080
Average common shares issuable
under employee benefit plans 1,837,928 3,201,940 2,269,210 3,082,792
Common shares issuable upon conversion
of ESOP preferred stock 7,446,687 7,556,106 7,478,147 7,576,412
------------ ------------ ------------ ------------
Total average common and common
equivalent shares outstanding 161,480,920 165,181,306 162,796,545 163,907,284
============ ============ ============ ============
Earnings:
Net income $ 219 $ 209 $ 793 $ 422
Less: Preferred stock dividend
requirements 14 16 46 47
------------ ------------ ------------ ------------
Earnings applicable to common shares $ 205 $ 193 $ 747 $ 375
============ ============ ============ ============
Fully diluted earnings per share $ 1.27 $ 1.17 $ 4.59 $ 2.29
============ ============ ============ ============
</TABLE>
(1) All share and per share amounts have been retroactively adjusted to give
effect for a two-for-one common stock split, effected in the form of a 100%
stock dividend, which became effective on January 26, 1996.
<PAGE> 1
Exhibit 12
RATIO OF EARNINGS TO FIXED CHARGES
AND RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FISCAL
THREE MONTHS ENDED NINE MONTHS ENDED PERIOD YEAR
---------------- ------------------ ENDED ENDED
AUGUST AUGUST AUGUST AUGUST NOVEMBER FISCAL YEAR ENDED JANUARY 31, DECEMBER
31, 31, 31, 31, 30, -------------------------- 31,
1996 1995 1996 1995 1995 1995 1994 1993 1991
------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
RATIO OF EARNINGS TO FIXED CHARGES
Earnings:
Income before income taxes $ 315 $ 298 $1,211 $ 621 $ 883 $ 594 $1,200 $ 793 $ 772
Add: Fixed charges, net 2,039 1,762 5,784 5,172 5,538 5,916 5,055 4,397 3,963
------ ------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes and
fixed charges, net $2,354 $2,060 $6,995 $5,793 $6,421 $6,510 $6,255 $5,190 $4,735
====== ====== ====== ====== ====== ====== ====== ====== ======
Fixed charges:
Total interest expense (1) $2,029 $1,745 $5,753 $5,154 $5,512 $5,899 $5,020 $4,362 $3,946
Interest factor in rents (2) 10 11 30 33 37 41 35 35 38
------ ------ ------ ------ ------ ------ ------ ------ ------
Total fixed charges $2,039 $1,756 $5,783 $5,187 $5,549 $5,940 $5,055 $4,397 $3,984
====== ====== ====== ====== ====== ====== ====== ====== ======
Ratio of earnings to fixed charges 1.2 1.2 1.2 1.1 1.2 1.1 1.2 1.2 1.2
RATIO OF EARNINGS TO FIXED CHARGES AND
PREFERRED STOCK DIVIDENDS
Earnings:
Income before income taxes $ 315 $ 298 $1,211 $ 621 $ 883 $ 594 $1,200 $ 793 $ 772
Add: Fixed charges, net 2,039 1,762 5,784 5,172 5,538 5,916 5,055 4,397 3,963
------ ------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes and
fixed charges, net $2,354 $2,060 $6,995 $5,793 $6,421 $6,510 $6,255 $5,190 $4,735
====== ====== ====== ====== ====== ====== ====== ====== ======
Fixed charges:
Total interest expense (1) $2,029 $1,745 $5,753 $5,154 $5,512 $5,899 $5,020 $4,362 $3,946
Interest factor in rents (2) 10 11 30 33 37 41 35 35 38
Preferred stock dividends (3) 23 23 74 72 80 97 85 82 47
------ ------ ------ ------ ------ ------ ------ ------ ------
Total fixed charges and preferred
stock dividends $2,062 $1,779 $5,857 $5,259 $5,629 $6,037 $5,140 $4,479 $4,031
====== ====== ====== ====== ====== ====== ====== ====== ======
Ratio of earnings to fixed charges and
preferred stock dividends 1.1 1.2 1.2 1.1 1.1 1.1 1.2 1.2 1.2
</TABLE>
(1) Total interest expense for the three months ended August 31, 1995, the nine
months ended August 31, 1995, the fiscal period ended November 30, 1995, the
fiscal year ended January 31, 1995 and the year ended December 31, 1991
includes capitalized interest.
(2) Interest factor in rents represents one-third of rent expense, which is
considered representative of the interest factor.
(3) The preferred stock dividend amounts represent pre-tax earnings required to
cover dividends on preferred stock.
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
This schedule contains summary financial information extracted from the
Condensed Consolidated Statement of Financial Condition at August 31, 1996
(Unaudited) and the Condensed Consolidated Statement of Income for the Nine
Months Ended August 31, 1996 (Unaudited) and is qualified in its entirety by
reference to such condensed consolidated financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> NOV-30-1996
<PERIOD-END> AUG-31-1996
<CASH> $6,218
<RECEIVABLES> $8,739
<SECURITIES-RESALE> $61,673
<SECURITIES-BORROWED> $35,023
<INSTRUMENTS-OWNED> $55,170
<PP&E> $1,287
<TOTAL-ASSETS> $169,226
<SHORT-TERM> $11,581
<PAYABLES> $18,965
<REPOS-SOLD> $76,992
<SECURITIES-LOANED> $7,726
<INSTRUMENTS-SOLD> $32,026
<LONG-TERM> $13,864
0
$878
<COMMON> $166
<OTHER-SE> $4,487
<TOTAL-LIABILITY-AND-EQUITY> $169,226
<TRADING-REVENUE> $1,696
<INTEREST-DIVIDENDS> $6,023
<COMMISSIONS> $461
<INVESTMENT-BANKING-REVENUES> $1,372
<FEE-REVENUE> $402
<INTEREST-EXPENSE> $5,753
<COMPENSATION> $2,100
<INCOME-PRETAX> $1,211
<INCOME-PRE-EXTRAORDINARY> $1,211
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> $793
<EPS-PRIMARY> $4.79
<EPS-DILUTED> $4.59
</TABLE>
